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Tax Deductible Lease

When Is A Lease Tax Deductible?

IRS Classification

It is important to understand the different types of leases before you try to understand the tax advantages of leasing. For IRS purposes, equipment leases generally fall into two categories, each with a different type of purchase option:

  • Non Tax-Oriented Leases: Legal ownership resides with the lessor; however, because the lessor is not considered to be at risk at the end of the lease and because the lessee has a nominal purchase option at the end of the lease, the lessee receives the tax benefit of ownership. (Lease intended as a security).
  • Tax-Oriented True Leases: Lessor maintains ownership, fair market value purchase option for lessee at the end of the lease.

Accounting Classification

For a lessee’s book purposes, equipment leases also fall in to two separate categories:

  • Operating Lease: The equipment acquisition is treated as a rental. Lease obligations are kept “off-balance sheet.” (True Lease)
  • Capital Lease: The equipment acquisition is treated as a purchase and the asset is included on the balance sheet.

Classification is determined independently at the inception of the lease by both the lessor and lessee. Generally, the lessee is attempting to achieve operating lease treatment because they wish to keep the obligation off their balance sheet and to charge the lease payments to expense accounts as they become payable.

True Tax Lease vs. Non-Tax Lease

When leases are structured as true leases, the lessee may claim the entire lease payment as a tax deduction. The equipment write-off is tied to the lease term, which can be shorter than IRS depreciation schedules, resulting in larger tax deductions each year. The deduction is also the same every year, which simplifies budgeting.

  • The true lease offers all of the primary benefits commonly attributed to leasing. It is a tax-oriented lease in which the lessor claims the tax benefits of ownership through depreciation deductions, but passes through to the lessee those benefits in form of reduced rentals (Rentals are lower because a percentage of the original equipment cost has been deferred to the end of the lease). The lessor owns the leased equipment for the life of the contract.
  • The non-tax lease passes the tax benefits of ownership to the lessee. While the lessor is legally the owner, the lessee may claim the depreciation and interest deductions. At the end of the lease term, the IRS expects that the lessee will choose to exercise their purchase option.

See also: True Tax Lease – Criteria

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